The Dividend Cafe - Trump, China, and Growth

Episode Date: April 21, 2017

Trump, China, and Growth by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. what we're seeing and doing and believing and all things investment oriented. And we certainly encourage you to check out DividendCafe.com to add to the podcast content, the various charts and other supporting materials that we have along with this week's thoughts. But there's enough going on here this week. We'll go ahead and get right into it. This week, some fun volatility has come back into the markets. Volatility that we had been forecasting would become normal again. The Thursday market rally appeared largely driven by a resurgence of hope from the Trump administration about their legislative agenda. But as we'll explain here this week, there may be more driving markets than meets the eye.

So let's get into it. China beats Trump. No, I don't mean that there was some negotiation or stare down on the global stage where China got the better of President Trump. In fact, the meeting of two weeks ago between Trump and China's President Xi Jinping has largely been viewed as a big success for the Trump administration. What I mean is that this week, China's news was really a bigger factor in driving markets than any news out of the White House. And it's been a while since the U.S. political front was not the biggest catalyst in financial markets. I refer to China's 6.9% quarterly GDP growth, beating expectations and beating last year's results quite handily. It represented the fastest pace in 18 months. It

continued to feed the narrative that maybe, just maybe, China's soft landing thesis can continue and their policymakers are doing an effective job threading this difficult needle. We'll talk more on the global growth story in a bit. Nominal trumps real. We should point out it was China's real GDP that grew 6.9% year over year in Q1. Its nominal GDP grew over 11%. So yes, that does indicate 5% inflation in China, but it also points to a general theme driving global markets, nominal GDP growth. Oil prices fit into this narrative as well. The sell-offs in the market recently have come on days of oil market distress. The up days have come largely, not exclusively, in conjunction with oil price stability. It reinforces the nominal growth acceleration

that we're talking about. None of this is to say that the French election or Trump's tweets or tax reform and certainly not earnings season are immaterial at present they are indeed but things like manufacturing pickup business investment capex sentiment confidence etc are all taking their lead from the nominal reacceleration story financials find a friend we've had a heavy concentration of financial companies release their Q1 earnings results already here at the beginning of earnings season, largely to mixed results of some have done quite well and some suffering minor disappointments. But perhaps the biggest news for financials came

this week in the form of the nomination of Randy Quarles to serve as the Federal Reserve Chair for Financial Supervision. This position, created in the aftermath of Dodd-Frank, has a lot of power in the new regulatory structure, and the position has been filled by Dan Tarullo, who has largely been perceived, for right or for wrong, as quite hostile to the big financial companies. Quarles, though, should he be approved as the new regulator-in-chief, is a Bush administration Treasury Department veteran, has run a large equity investment firm. The overall environment feels that many of the people being appointed and advising the administration are more market friendly in their natural intuitions than markets have been used to. Paying for a hamburger Tuesday and getting

it, well, Tuesday. Automaker saw a 17% drop in sales in Q1 on an annualized basis, the worst decline since the early stages of recovery post-crisis about eight years ago. We think we were a tad early with the forecast, but our call in 2013 and 14 was that 2016 and 17 sales were being brought into the present then due to excessive incentive programs. We think that call is proving prescient. Defend that assumption. We talk a lot about how index investors in the emerging markets are excessively exposed to export-driven countries, with companies that often serve as a leveraged bellwether on global growth, not local market, domestic, organic opportunity, the very thing we're trying to exploit as emerging markets investors. Why do we assume that the index carries such a focus on exporters, you know, from people, countries exporting from emerging to developed countries? Well, China, Korea,

and Taiwan now represent over half of the index. Those three countries alone, which are well known to be very large export-driven economies. Sunday relaxation. I've worked most Saturdays for my entire adult life, but I've also tried to make Sunday a non-work day for most of the same. Between church and my family and a general need for rest and family time, it's a good habit to get the markets and state of geopolitical affairs out of my mind at least one day per week. Back in 2008, recurring Sunday afternoon announcements, Bear Stearns, Lehman Brothers, Citigroup, they disrupted that routine

more than once. And this coming Sunday, let's just say it may be difficult as well. As French voters go to the voting booth, I cannot recall another election where people had less of an idea as to what to expect than this one, particularly with some of the leading options are so, so extreme. particularly with some of the leading options, are so, so extreme. One of these things is not like the other. We get asked from time to time about the relative value of silver versus the cost of gold. For indeed, the ratio between the two is quite a bit off from its old averages. The gold-silver ratio has become completely obsolete in our opinion.

It has no economic correlation or relationship anymore whatsoever. After studying this exhaustively, we came to the conclusion that looking at such things like historical price relationships creates incredible problems of being fooled by randomness. Even gold investing itself has proven to be a woeful inflation hedge for a full generation and has really become just a speculative trading tool. But when it comes to silver, it isn't treated as a currency proxy as gold is and has a totally different industrial profile. We just don't believe the ratio to gold has any economic or statistical meaning. Floating beats sinking. We've been heavy investors in the floating rate bank loan space for many years, appreciating the interest rate protection they've provided as

bond investors feared rising rates ever since rates went to zero back in 2008, and yet also respecting the reality that we were taking on extra credit risk in exchange for this interest rate projection protection rather and in exchange for a very attractive current yield as well this asset class has lived up to expectations and many bonds within the strategy are seeing the rates they pay clients increase as the underlying bank loans experience rate resets to the upside. Roughly two-thirds of bank loans in the universe are trading above par value now. So the days of 90% of these bonds trading at a discount of their par value are seemingly gone. Fundamentals in the space appear stable and in modest, let alone accelerating, economic conditions, we expect the asset class to continue to do just fine.

However, valuations are richer and quite frankly, flows concern us, meaning the $12.7 billion of inflows to retail mutual funds in this space. This warrants concern no matter what. Always be wary of that which is popular. The chart of the week at DividendCafe.com is really quite interesting. It's borrowed from our friends at Gavcal Research and they start off with the basic fundamental question is the economy ready to surge based on fiscal stimulus, Trumpian policy, things like that. And then if you answer yes, we ask the question, what is the Fed about to do? And if you answer no, we ask the same question. And then it generates kind of different scenarios as to what somebody's outlook may be, what would be the right way to be

positioned if you thought this about the economy, but this about the Fed, thought this about the economy but this about the Fed or this about the economy instead of this about you know etc. So there's a couple options laid out in that chart that we happen to agree with wholeheartedly. We encourage you to check it out. I leave you this week with a wonderful quote from Warren Buffett. During scary periods you should never forget two things. First widespread fear is your friend is an investor because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who simply sit for an extended period of the collection of large,

conservatively financed American businesses will almost certainly do well. We'll leave it there for this week of our Dividend Cafe podcast. We hope you got a lot out of it. We welcome your questions and comments anytime. I encourage you to go to our website. And thank you very much for listening to Dividend Cafe.